Final answer:
The question involves calculating potential adjustments to an adjustable-rate mortgage (ARM) based on specified terms, including the interest rate caps and margin. ARMs start with a lower initial interest rate, but can change over time, potentially leading to higher payments.
Step-by-step explanation:
The question pertains to an adjustable-rate mortgage (ARM), which is a type of loan used for home purchases where the interest rate can change over time, typically in relation to an index such as the 1-year Treasury Bill yield. The initial contract rate of 5.25% is the starting interest rate of the mortgage, and the interest rate caps mentioned as 2/6 indicate that the rate can increase by up to 2% annually, but not more than 6% over the life of the loan. The margin of 2.50% is added to the index rate to determine the adjusted interest rate on the ARM after the initial period.
For borrowers, an ARM can offer initial lower monthly payments, but there's an inherent risk of payment increases if interest rates rise. This can lead to substantially higher costs over the term of the loan. Understanding the terms and potential risks of an ARM is crucial for homeowners to avoid financial difficulties should interest rates increase significantly.